Enhancing the Efficiency of Board Decision Making: Lessons Learned from the Financial Crisis of 2008

40 Pages Posted: 4 Feb 2009 Last revised: 17 Nov 2009

Date Written: September 14, 2009

Abstract

As a result of the financial crisis of 2008, the employment compensation policies and decisions of Wall Street corporate boards have come under close scrutiny. Specifically, the willingness to approve company-wide compensation plans that resulted in the paying out of billions of dollars in bonuses, even in the face of deteriorating financial and economic conditions, has been a highlight of the controversy. If only these firms had retained the bulk of these large annual bonuses over the last several years when the financial markets were noticeably in decline, perhaps the economic impact of the current financial crisis would have been less severe.

It is now understood that board approval of compensation policies that are heavily weighted toward large bonuses can encourage the pursuit of fake alpha and that the decisions to pay out huge amounts of company capital in the form of bonuses may primarily be the result of fake alpha being successfully achieved. In terms of corporate governance, these decisions reveal how opportunistic rent seeking stakeholders can pressure the corporate board into excessively risky decisions that can jeopardize the financial health of the corporation. The question then becomes whether corporate law needs to be modified to deal with this weakness in corporate governance and if so, how should it be done. In this article, it is argued that courts should require a public company's board - a board composed of a majority of presumably independent and disinterested members - to fulfill an enhanced duty in the process of deciding to approve policies or making decisions that on their face implicate both opportunistic rent seeking behavior on the part of one or more company stakeholders and the financial health of the firm. Such board decisions would necessarily include, among others, those decisions that involve moving massive amounts of cash out of the company and into the pockets of one or more stakeholders (huge company-wide bonuses, large executive management team compensation, large dividend payouts, aggressive stock buybacks, etc.).

Keywords: Delaware, Journal, Corporate, Law, DJCL, financial crisis, 2008, compensation, bonus, bonuses, Wall Street, payouts

JEL Classification: K22

Suggested Citation

Sharfman, Bernard S., Enhancing the Efficiency of Board Decision Making: Lessons Learned from the Financial Crisis of 2008 (September 14, 2009). Delaware Journal of Corporate Law (DJCL), Vol. 34, No. 3, 2009. Available at SSRN: https://ssrn.com/abstract=1337124

Bernard S. Sharfman (Contact Author)

R Street Institute ( email )

1050 17th Street Northwest
#1150
Washington, DC 20036
United States
(202) 525-5717 (Phone)

HOME PAGE: http://www.rstreet.org/

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